Built to Last

Research: If the price is right, does it matter which company guarantees an annuity?

Stout: My opinion would be yes. Price is really not even the long-term consideration here. I think when you’re buying these kinds of guarantees, particularly in the variable annuities space today, you’re really going to want to buy from an organization that’s going to live longer than you are going to live. People need to understand who they’re buying from and what their financial strength is, how they manage risk in their business. And this is very important for the financial advisors, who really need to have a very good understanding of the terms of the annuities that are being sold and the overall contract that’s being sold by particular carriers.

What happens if a guarantor defaults?

Any sort of default on the part of an insurance carrier has been a very rare event. I’m trying to think back, and over the last 20 years, I can’t think of anything substantive. If this situation were to take place, in the U.S. market there’s a series of state guaranty funds in place. My understanding is that if a carrier were unable to live up to its obligations — had solvency issues — then the state funds would then apply and that’s the offset that would take place. The state funds aren’t really assuring 100 percent of the dollars, but that’s the backup behind the system. This is why it ultimately comes back to the issuer, as the primary corporate entity standing behind an annuity. When buying guarantees, this is what you ultimately need to be sure of.

So how great is the risk of default?

We could all sit here today and say nothing is going to happen in the U.S. market, but if there’s some unknown shock that changes how we do business and assess the risks — remember, in Japan the markets declined 75 percent at one point — then most likely, the large companies have the strength and the ability to withstand these shocks more than smaller companies. People need to buy from companies that can absorb that kind of shock to the system, because with a lot of these guarantees like living benefits, consumers are buying them as a protection against significant market decline. These products give them a baseline guarantee for a portion of their retirement savings.

Have smart carriers built this risk into their operations?

The major players in the industry are doing their best to understand and address the behavior of the policy owners that are buying their guarantees. Carriers are trying to anticipate this behavior through hedging, product design and the management of their businesses, so they can be better prepared to deliver the benefits they’re selling. Typically the larger companies are in a variety of businesses and there is a diversification of risk that is implicit in these multiple businesses they are in. As an example, ING is one of the very few that sell both variable and fixed annuities; there is a risk diversification in being in both businesses simultaneously, and I think that’s one of the considerations people should take into account.

How can advisors mitigate this risk for their clients?

What advisors need to do is really be knowledgeable about the products they’re selling and the companies that they represent, how those companies are managing the risks that are inherent in the products they are offering and how they service the customer. What’s their long-term record of treating the customer? Past performance is never a guarantee of future results, of course, but if an advisor understands the products, the carriers, their financial strength and risk management, I think that helps him or her mitigate the risk for his or her clients.